This – in its wake – would bring about a run and collapse of Greek banks; cause many bankruptcies; a steep rise in inflation and unemployment; and spark riots, assert the pessimists. Foreign investors would stop lending to the country, and there would be a meltdown, leading to social upheaval and poverty; potential political extremism; and perhaps, a military coup. A major danger, warn the pessimists, is so-called European contagion – notably a run on Portuguese, Spanish, Irish and possibly Italian banks on the expectation that these nations will also be forced to leave the euro.
Economists and bond strategists have calculated that losses could range from €351 billion ($432 bn) – notably Greece’s estimated national debt – to as much as one trillion euros. According to the pessimists, there is thus no option – Greece must remain in the euro.
Swift exit of Greece better than lingering pain
Life, however, is somewhat less simplistic. For a start, regardless whether Greece remains in the euro or not, the country is not in a position to repay its debts. Thus the major portion of estimated losses in the event of a Greek exit would be double counting. In or out of the eurozone, they have to be written off.
Secondly, if Greece with all its uncertainty remains in the eurozone, a cloud of uncertainty will linger on with generally depressed stock markets; lowered confidence; and miserable European investment and growth. These costs are huge and unquantifiable.
Swift extraction of the Greek tooth, with all its pain, could thus be preferable to the lingering and worsening pain of a Greek abscess.
Run on Greek banks has already taken place
To be sure, the run on Greek banks has, in the main, already taken place. Since the eruption of the crisis in 2010, domestic deposits at Greek banks have tumbled from 242 billion euros at the end of 2009 to 170 billion euros at the end of March, according to Simon Ward, chief economist at Henderson Global Investors.
Banks have stanched the outflow by borrowing from Greece’s central bank, which in turn has loaned money from the European Central Bank (ECB). The longer Greece remains in limbo, the greater the outflow and uncertainty. When Greece defaults, there would be an immediate “bank holiday” to sort out the changeover – and the drachma would tumble.
Legal preparations for exit are in place
According to sources, lawyers and banks have already begun planning for changes in contracts and other documents. The European Union (EU) and International Monetary Fund (IMF) would have to provide transitional aid. Imported inflation would surge, but the Greek government could well institute temporary price controls. Ultimately, money which left the country would return to buy businesses and real estate at bargain prices. Investment and employment could increase, and the drachma could stabilise and even rally. Exports would improve; and if there is good policing and security, tourism – a major earner – would jump. Greece would have to institute tax reforms to counter avoidance loopholes for wealthy shipowners and evasion of trades people, professionals and others.
Ring fencing Spain and Italy the key
To prevent contagion in the eurozone, the ECB and IMF would have to ring-fence Greece. They would also have to show the markets a heavy hand with a “shock and awe” policy, according to Brendan Brown, chief economist of Mitsubishi UFJ Securities International.
A mainstream scenario for the day of Greek exit, according to Brown, would be joint declarations in Washington, Frankfurt, Brussels, Tokyo and Athens to give the go-ahead for the US and the ECB to ease money and to pre-empt any financial upheaval.
A massive European Financial Stability Facility would be available to Spain to help with recapitalisation of its banking system. The ECB would slash interest rates and show its hand in purchasing Spanish, Portuguese and Italian bonds, while the ECB, Federal Reserve and other central banks would be ready with short-term finance to help distressed European banks.
Of course, over the long term, the eurozone will have to reform; and perhaps it will eventually shrink to a more workable monetary and fiscal union of core nations.
Gloom prevails at the moment. But the pessimists may be wrong, and the predicted Greek and European Armageddon may not occur.